Week 2 Flashcards
What is AID and how is it used in balance sheets
AID - Asset Increase Debit, is a handy reminder for how to begin a balance sheet.
Similarly, liability increase credit can be used to remember how to start a financial assessment of liabilities.
What falls under the categories of credit and debit within a balance sheet
Debit is always an expense or asset, while credit will cover income, liabilities and capital.
DEACLILC
State the accounting equation for balance sheets
Assets = Captial + Libailities or Liabilities = Assets - Capital or Capital = Assets - Liabiities
What is an alternative name for the balance sheet
SFP = Statement of financial position
On the statement of financial position, assets and claims are usually grouped into categories. What are the two types of assets and how do we classify them?
Assets are divided into:
Non-current assets:
This form of assets (also called fixed assets) is used by the business over a period likely exceeding 12 months. Tangible forms of non-current assets are usually:
- Property
- Plant
- Equipment
However, this form of asset can be tangible or intangible. This form of assets will suffer from depreciation as the assets usefulness and effectiveness reduces overtime.
Current assets:
Assets used within the short-term of the business operations and will likely be converted into cash within 12 months. This can also relate to assets used on a day-to-day basis by the business. The following are different examples of Current assets:
- Inventories (work-in-progress or finished goods)
- Trade receivables (Debtors)
- Cash and Bank
- Prepayments
On the statement of financial position, assets and claims are usually grouped into categories. What are the two types of Liabilities and how do we classify them?
Similarly to the classification of assets:
Current liabilities are amounts that are due to be settled within the business’s normal operating cycle (typically within 12 months), while a non-current liabilities are liabilities which can remain for periods usually exceeding 12 months. Non-current liabilities will typically concern loans with a long-term repayment plan, usually for the Lender to receive interest.
Define depreciation and explain the ways it can be calculated.
Depreciation is an attempt to measure the portion of cost of a non-current asset that has been depleted in generating the revenue recognised during a particular time period.
For our calculations we focus on using the following types of depreciation methods:
Straight line: where a certain percentage of the original cost is depreciated from the value of the asset annually.
Reducing balance: Where a percentage of the assets reduced value after depreciation was calculated for the previous year, is then used to calculate appreciation of the asset.
Depreciation is used to calculate “
Net Book Value”, express the equation for this.
Asset value - Depreciation = Net Book Value
Define the following terms related to current assets:
- Inventory
- Trade receivables
- Cash/Bank
- Prepayments
- Inventory: Good bought and sold by the firm.
‘Inventory’ appearing the BS/SFP are the goods bought with the intention of resale that has not yet been sold. They are still owned by the firm
The value of ‘Inventory’ in the BS/SFP refers to the value of stock at the end of the financial year
-Trade receivables:
Sales that the firm has made for which no money has yet been received – i.e. MONEY OWED TO THE FIRM
Sometimes, not all receivables pay up. Their debts would then have to be written off – in other words, reduced to a zero value
The amount for ‘Receivables’ appearing in the BS/SFP shows what the firm is really confident about receiving
- Cash/Bank:
This is the actual cash the firm has both in hand and in the bank.
If the firm has an overdraft, then the bank account will appear as a liability in the BS/SFP
- Prepayments: This occurs where an entity has paid for goods or services but not yet received all the economic benefits They are the opposite to Accruals Most common examples: Rent paid in advance Line rentals or service charges Insurance premiums
What are Accruals
Accruals are an expense that is ‘incurred’ but not paid for until sometime later
‘Incurred’ means the entity has had the benefit of the goods or service
Most common examples:
Phone – quarterly or monthly in arrears
Other utilities – gas, electric, water, etc.
Services – legal or accountancy
Show the difference between accruals and prepayments.
ACCRUALS –
Increase the Expense in the Income statement/Statement of Comprehensive Income
Increase the Accruals in the Current Liabilities – balance sheet/Statement of Financial Position
PREPAYMENTS
Decrease the Expense in the Income statement/Statement of Comprehensive Income
Increase the Prepayments in the Current Assets – balance sheet/Statement of Financial Position
Explain the following terms:
- Capital/Equity
- Net Profit
- Drawings
- Captial/Equity: The claims of the owner(s) against the business
Depends on the type of firm:
If firm not listed, simply the owner’s capital
Limited firms = share capital (‘equity’) - Net profit: Profit for the year after all deductions
Final retained profits for the year are added to the capital to give a subtotal = forms a new balance on capital going forward - Drawings: Money taken out of the business by its owners, but is not an expense, rather an appropriation of the firm’s funds
Does the Balance sheet/SFP tell you what the business could sell for?
It does because it doesn’t take into account the following aspects:
- Historic Cost
- Element of judgement in items such as provisions, depreciation, inventories and write-down values
- Doesn’t take the non-financial elements such as goodwill or experience/reputation of the business
What are the limitations of the BS/SFP
Does not tell you the market value of a business – a ‘snapshot’ of the firm at a point in time
Assets are not valued at market value as depreciation does not accurately measure the loss in value of non-current assets
Maybe hiding relevant details
Only represent the situation of the business on a particular day
Identify the specific cases where you would use a statement of financial position.
You use a statement of financial position to express the following information for the following reasons.
- Assessing Financial Position
- Viewing Trend Analysis
- Communicating with those outside the business
State the calculation used for generating the cost of sales
Opening inventory + Purchases - Purchase returns - Closing inventory
= Cost of sales.
or
(opening inventory + Purchases) - (Purchase returns + Closing inventory)
What are Dividends
Dividends = a share of the firm’s profits
Can be ‘paid’ or ‘proposed’
Paid: Appropriation of profit (an expense)
Proposed dividend = not actually been paid
However, firm has declared it will pay a dividend and so now OWES it – included under payables in the firm’s SFP (current liabilities)
Deemed to be an appropriation of profit – not an expense
Typically dividends are owned by shareholders of a company, allowing them to receive a share of the firm’s profit.
What are the three main ways in which a business entity may grow
Three main ways in which an entity may ‘grow’
Raise more capital
Borrow more
Make and retain its profits
Answer the following question relating to a sole trader/Partnership and Limited liability companies:
- What type of liability does the business have
- Is the business separate from its owners
- How is capital produced by the business
- How is the business taxed
A sole trader/Partnership has:
- Unlimited liability
- The business is not a separate legal entity from its owners.
- It is the owners that introduce capital into the business.
- The owner of the business is taxed as an individual.
A limited liability company (LTP) has:
- Limited liability
- Is treated as a separate legal entity from its owners7
- Capital is raised through the sale of shares. shares traded, nominal share value, market share value and share value premium will generate the capital income.
- This business will be taxed as a company.
What is Share capital
Share premium is the excess of the issue price of shares over the nominal value
It is a capital reserve and thus cannot be distributed as a dividend
When a firm issues shares potential shareholders subscribe (i.e. pay) for them.
If a firm issues a share with a €1.00 nominal value at a price of €1.40 per share, €1.00 is added to the firm’s share capital while the €0.40 is added to share premium.
If a company sells 400,000 shares for £15 each, while they only had a nominal value of £5, show how this will impact a balance sheet at the end of the business year
In the Balance sheet/SFP:
INCREASE Share Capital by €2 million [400,000 x €5]
INCREASE Share Premium by €4 million [400,000 x (15 – 5)]
INCREASE Cash by €6 million [400,00 x 15]
identify the calculation for Net assets
All Assets - all Liabilities = Net worth of Business (Capital)
in terms of the accounting equation:
- Assets - Liabilities = Capital
